The word “adopt” has a fairly clear meaning to most people. When you adopt a child, you take sole custody of caring for and nurturing that child as your own, allowing him or her to flourish to their fullest extent. You don’t adopt a child “in principle”. Nor do you simply agree to “act on” that child.
But these are precisely the sorts of weasel words now emerging from both the Coalition and Labor as they seek to avoid adopting Royal Commissioner Kenneth Hayne’s most controversial recommendation.
Namely: the complete abolition of conflicted commission payments by lenders to mortgage brokers.
More than half of all loans in Australia are signed using the services of a broker. Some borrowers are aware that, in return for this apparently "free" service, their broker will receive a commission – both upfront and ongoing – from the lender they ultimately go with.
Many borrowers, however, are unaware of this hidden web of payments – although they’re required to be told.
In drafting his final report, Commissioner Hayne was in no mood for mincing words about what he thinks of such payments.
“Value-based commission paid by lenders to mortgage brokers are a form of conflicted remuneration,” he states. “That is, value-based commissions are a form of remuneration that can reasonably be expected to influence the choice of mortgage, the amount borrowed, and the terms on which the amount is borrowed.”
Such commissions “drive poor customer outcomes”, according to Hayne.
Indeed, borrowers who use brokers – as opposed to those who deal direct with a lender – consistently have higher loan-to-value ratios and higher rates of default, according to evidence heard by the Commission.
So why are brokers paid this way, Hayne inquires?
The answer: because that’s how we’ve always done it. When the Productivity Commission looked at the matter, it found the structure of mortgage broker pay was simply "entrenched…as a matter of convention".
Not good enough, according to Hayne, who has recommended the abolition of trail commissions paid to brokers in the next year to 18 months, followed by the complete abolition of all commissions paid by lenders to brokers in the following year to 18 months.
Borrowers, instead, should pay brokers directly for the costs involved in advising on and arranging their loans.
Both the Coalition and Labor have agreed to phase one of Hayne's plan, agreeing to abolish trail commissions paid on a continuing basis to brokers. How could they not, after reading Hayne’s blunt description of them as “money for nothing”. “Why should the broker, whose work is complete when the loan is arranged, continue to benefit from the loan for years to come?” Hayne asks.
Quite right. Talk about fee for no service.
But both the Coalition and Labor are yet to outline their plans to act on Hayne’s phase two plan for brokers, amid a hornets’ nest of outcry from the industry. Banning commissions and getting consumers to pay for mortgage advice would variously destroy the industry, destroy competition in the banking sector and rob people of much-needed assistance.
Not so, says Haynes.
Australians value the services of brokers and would simply be asked to pay a transparent price for it. Longer term, competition between brokers would drive down the cost.
Australians are paying the cost of commissions anyway, even if they don’t realise it – it simply increases the interest rate they ultimately pay on their loan as the bank seeks to cover costs.
Further, there’s no reason why brokers' fees could not be "capitalised" into a loan. Put simply, the upfront broker fee agreed to by the borrower could simply be added to the amount they borrow from the bank and paid down over time.
On competition, Hayne is not convinced. “The argument assumes that mortgage brokers are contributing significantly to competition in the home loan market. Recent reports raise doubts about this assumption. The Productivity Commission found that while the pro-competitive effects of brokers in the market were significant and obvious in the 1990s, they have since declined.”
Banks may be competing with each other more to get the loans originated through brokers, but, crucially, “Rather than competing on the basis of who is offering the best product at the best price, lenders are competing on the basis of who can offer higher commission to aggregators and brokers.”
In addition to banning commissions, Hayne also wants brokers subject to a "best interests" requirement – beefed up from the current “not unsuitable” yardstick for their advice.
Longer term, says Hayne: “It has not been explained why the duty a mortgage broker owes to a borrower should differ from the duty a financial adviser owes to a retail client.”
Australians have spent most of the past decade learning about how financial advisers cannot be paid commissions and give genuinely unbiased advice. Only a fee-for-service model works for financial advisers.
“Why not treat mortgage brokers as financial advisers?” asks Haynes. Why indeed.
The Future of Financial Advice reforms of 2013, which cracked down on financial advisers' conflicted remuneration, were silent on the subject of mortgage brokers.
But buying a house and getting a loan is the biggest financial decision many Australians make. In many ways, it’s even more important that the advice they receive is in their interests.
When it comes to mortgage broking, the holy trinity of financial advice applies: there’s no such thing as a free lunch; if it sounds too good to be true, it probably is; and she who pays the piper calls the tune.
Reform of broker pay is long overdue. Hayne's proposals deserve to be adopted, whole-heartedly.
Jessica Irvine is a senior economics writer with The Sydney Morning Herald.